Beware dangerous volatility following Brexit, say market experts

Beware dangerous volatility following Brexit, say market experts

The United Kingdom’s decision to leave the European Union confounded both the markets and the many experts that predicted a continuation of the status quo. With a vote of 51.9 to 48.1%, citizens of the UK elected to leave the EU and that decision has sent shockwaves across the globe. In an era of globalization, no nation exists in a vacuum and certainly not the UK – the fifth largest economy in the world.

So what does it all mean for Canada? Wealth Professional spoke to some experts in the field on what the fallout from Brexit may mean for the Great White North.

Florian Ielpo is head of Macroeconomic Research, Cross Asset Solutions at Unigestion. While the result was a surprise to him, his firm did have contingencies in place for such an outcome.

“Over the past week the markets, betting sites and different surveys were pointing at a 51-49 vote in favour of remain,” he says. “On our side we remained cautious in the sense that we decreased the leverage in our portfolios and kept our bond exposure in case the Leave vote passed.”

Now that the Leave side has made its voice heard in emphatic fashion, what does it mean for the global markets? Ielpo explains what the vote may mean in the weeks, months and years to come.

“No country has ever left the European Union. On our side we think there are three key macros – recession, inflation and market stress,” he says. “For us, it’s not a question of recession and inflation worldwide, Brexit has nothing to do with that, it’s a question of market stress.”

With the pound falling to its lowest level since 1985 and the FTSE 100 experiencing its biggest one-day fall since the collapse of Lehman Brothers in 2008, clearly Brexit is being felt across the markets. Although there was some recovery later in the day, that uncertainty will likely continue for some time yet. “They have strong commercial ties – the UK exports a lot of financial services to the EU and the EU exports a lot of goods to the UK,” says Ielpo. “From a pure economic standpoint, they have a natural incentive to find an agreement rapidly. Hopefully quicker than what we saw with Greece, which was a mess.”

Pedro Antunes is deputy chief economist with the Conference Board of Canada. He believes the domestic market here is vulnerable to the headwinds emanating from Europe.

“Economies are more integrated and global now and because of that we are a lot more concerned about what happens outside our own country,” he says. “ It’s very hard to know how long these jitters will last in terms of the global markets, but it’s certainly not going to be a positive for the global economy or Canada.”

In particular, a global shock is sure to have a malign effect on the commodities market, of which Canada is so dependent.

“We have already seen some hits to commodities, so the concern is that this will have implications for global growth,” he says. “If there’s implications for global growth then there will be implications for the demand for oil and energy and that will have repercussions for Canada. You are already seeing that with the exchange rate.”

While Canada is likely to feel the effects of Brexit, the implications for the UK itself will be much more severe, in Antunes’ view.

“It sets the stage for a lot of uncertainty for a number of years to come. The UK has been a bastion of investment and most of that has been because it has access to the European Union. The business sector hates uncertainty and will essentially park themselves and wait and see about investment. So that’s going to have some major repercussions as real investment goes elsewhere.”

The European Union losing one of its members is an event without easy comparison. The fact that the member in question is also its second largest economy compounds the situation.

“Until the terms of the separation agreement are known, it will be difficult to predict the full economic and fiscal effects of Brexit,” he says. “However, we do expect gross domestic product in the UK to weaken amid lower business investment and exports. Potentially, the consequences of Brexit could push the UK into a recession.”

In addition, the political implications of Brexit (UK Prime Minister David Cameron has already resigned) are likely to be epochal.

“We expect the Scottish independence movement may well see a surge in support as Scotland is also pro EU,” says Cooper. “In Europe, Brexit may fuel anti-euro, anti-immigration and anti-austerity feelings and provide support for populist parties, such as Syriza, Podemos and National Front, which could undermine established political parties.”

While uncertainty seems to be the word of the day as far as the political and economic ramifications of Brexit go, Ielpo of Unigestion believes events today, while extreme, are still following a familiar macroeconomic trend.

“The pattern that we have today is very close to the pattern we have had for the past month. The scale will depend on the economic and political consequences of Brexit, but the direction we more or less know,” he says. “It’s short equities, it’s short credit, it’s long gold, short commodities and long bonds. The pattern is very consistent.”

Thing is, it was a political decision to leave and a decision regarding immigration controls. Diageo and British Imperial Tobacco actually went up after the fact. People are consuming whatever they were before plus some. Some are celebrating while others are crushed. This is not a crisis and it is not a contagion. Look on the bright side--if they go into a recession and the pound goes down further, then holidays in the UK will be on a huge discount. You can have tea with her Majesty (not literally), visit Big Ben and drink bad tea with horrid service in their best restaurants. And buy pounds at the lowest rate since whenever!